, Columnist
What You Should Know About r*
Finding the neutral rate of interest will ensure the economy is growing at potential and inflation is contained.
Balancing act.
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As the Federal Reserve gradually normalizes its monetary policy, market participants will hear a lot more about r*, the “neutral rate of interest,” which helps equilibrate financial markets when the economy is growing at potential and inflation remains contained and stable.
Should central banks hike interest rates well beyond this level, they will harm growth, threaten recession and deflation, and impose avoidable costs on society. Should they maintain rates below that level for too long, they will run the economy too hot, see future inflation eat away at the purchasing power of households, and also risk financial market instability that would further harm social welfare.